WEAKNESSES

Dependent on the agricultural sector and a small number of trading partners (in particular, Brazil and Argentina)

Weak governance (corruption and patronage)

Large informal market (40% of GDP)

RISK ASSESSMENT

Resilient growth in 2018

Activity is expected to remain firm in 2018, buoyed by domestic demand and agricultural exports. The latter will benefit from the improved economic situation in both Brazil and Argentina, the country’s main trading partners, as well as from the moderate rise in the price of soya (42% of exports). Nevertheless, the contribution of external trade to growth will be limited because of the lively pace of imports. The healthy state of the agricultural sector will benefit the industrial sector, mainly centred on processing agricultural products like soya (oil, flour) or beef (mainly leather). The dynamism of the automotive parts assembly and textiles segments within the country’s maquilas (foreign-built factories, typically in free zones) and of the construction sector should help support private consumption by creating jobs. Households will also benefit from the higher minimum wage. Higher public spending will underpin activity, but political disagreements could delay the implementation of some infrastructure projects (roads, metro, airports). Private investment will be limited by the still underdeveloped infrastructure, despite an attractive fiscal policy for foreign investors. Inflation is expected to settle in the middle of the central bank’s target range (2-6%). The central bank will tighten monetary policy if there are strong inflationary pressures, particularly on food prices. It will also intervene to stabilise the guarani, the local currency, if it depreciates too strongly following a fall in the price of soya or an increase in the price of oil. Meanwhile, the banking system remains fragile, as it is highly dollarised and heavily dependent on the agricultural sector, which represents most of the loans granted.

Prudent budget policy and balanced external accounts

The government is expected to continue with the implementation of the budget reforms approved at the end of 2013, which include a law on fiscal responsibility, limiting the deficit to 1.5% of GDP, tax reforms, and a framework permitting public/private partnerships (PPP). In 2017, the budget deficit remained below the limit fixed by law and this position is expected to last until 2018. The lively pace of economic activity should help boost tax receipts and offset the increase in public spending, mainly on infrastructure. However, the country is expected to widen its tax base, one of the narrowest in Latin America, in order to more easily reach its fiscal deficit targets, while developing its infrastructure. Given the fiscal prudence, the public debt is expected to remain contained, even if financing it will still broadly be through external finance, in particular via the issuance of dollar-denominated bonds.

Economic recovery in Brazil and Argentina is expected to stimulate agricultural and energy (mainly hydroelectric) exports, excluding any negative weather events. The trade surplus (5% of GDP) will be moderated by strong import growth associated with dynamic private consumption and infrastructure investments. Meanwhile, changes in terms of trade will continue to be a key factor in the current account balance. Under these conditions, FDI flows, chiefly in the agricultural and infrastructure sectors, will help maintain foreign exchange reserves at a satisfactory level (seven months of imports).

Political difficulties in advancing the reforms

The next presidential and parliamentary elections are due to be held on the 22nd April 2018 and are expected to be won by a member of the Colorado party, the party of the current president, Horacio Cortes, who is ineligible to stand having withdrawn his proposed amendment to the Constitution allowing for presidential re-election. This proposal hampered the implementation of reforms, as it was heavily contested by the opposition, as well as by members of the Colorado Party. Several members of the Colorado Party (PC) also criticised President Cortes’ reform programme, which was based on opening up the capital of state-owned enterprises to private participation and the multiplication of infrastructure projects in private/public partnerships. It is therefore likely that the new government will be more reluctant to raise funds from the private sector to finance infrastructure developments, which could adversely impact FDI flows. Meanwhile, the business climate remains difficult, particularly because of corruption and the size of the informal economy.